· Features

Changes to public sector pensions on procurement

Newspaper reports in recent weeks have suggested that the Government is intending to relax the present rules on pension rights for public sector workers moving into private companies. The present requirements cause significant administrative headaches and costs for companies acquiring businesses from a public sector or taking outsourcing contracts and, by those at least, these proposed changes will no doubt be welcomed.

The Government "fair deal for staff pensions" published by the Cabinet Office in January 2000 and updated by guidance note from the Treasury in June 2004 gave public sector workers special protection on their pensions when transferring out of the public sector. Whereas other employees transferring with their business only have a right to contributions of up to 6% of salary to a defined contribution benefit of 6% of salary, public sector workers have had a right to continue in the same defined benefit scheme or an equivalent scheme.

The effect of this has been a significant headache for the new private sector employer. Public sector schemes are often generous and involve benefits (such as enhancements on redundancies) that are not found in other schemes. In order to ensure that the new scheme is "broadly comparable" (to use the relevant jargon), the new scheme must be certified by the Government Actuary's Department as such. This leaves the private sector employer with a stark choice: join the public sector scheme (if they are permitted to), set up or join a "GAD certificated" scheme, or don't do the deal.

The process of complying this can be incredibly time consuming. Even on transactions involving assets where very few employees transfer it is often the case that the issues relating to GAD certification and pension provision take as much of the time and effort of negotiation as everything else. The employer is then saddled with participation in a complex and often generous pension arrangement for a very small number of employees, which is very rarely cost efficient. Additional rights to transfer the accrued public sector scheme rights to the new scheme can have significant effects on funding.

Other employees generally accept that when the business they are part of is transferred out of the present employer they will lose their participation in any defined benefit pension scheme for future service. Whereas employees are rarely pleased with this situation, it is usually met with equanimity. Public sector employees, however, are not used to this position. They are generally aware of the value of their pensions which are often used as a recruitment tool, particularly in areas of the public sector where basic pay is not particularly generous. A large proportion of public sector workers are aware of the basic concept of the Fair Deal, which is that their pension will not be stopped or changed if they are outsourced. Inevitably, any proposed change to this arrangement is going to cause significant concern for public sector workers.

This is not to say that the proposal does not make good business sense. From the Government's point of view, any oursourcing or selling of assets (the latter presumably on the rise given the drive to cut public sector spending) should be optimised to maximising returns. The requirement to comply with the Fair Deal has significant cost issues which has inevitably driven down the value of bids made to the public sector.

However, there is a disadvantage to the Government in scrapping the Fair Deal. The existing requirements did at least encourage the transfer of benefits already accrued in public sector schemes to the private sector arrangement and therefore remove the obligation from H M Treasury. The cost of public sector pension schemes is very significant and although they are not subject to the same funding regime as the private sector, they are generally not thought to be as well funded. This may, of course, lead to cash flow problems in the future when those schemes continue to pay out benefits for the more generous sections relating to older public servants. The end of the fair deal is likely to see an end to those transfers and retention by the public sector of a larger proportion of historic liabilities.

The issue of funding is a longer term one and in the short term it seems hard to see how the Government could refuse to at least amend Fair Deal. Doing so will make bids more competitive and therefore presumably reduce the need for public sector spending cuts in other areas. However, inevitably, this is going to be of great concern for public sector employees and their unions which will, of course, spill over into employee relations issues for any outscourcer or other employer in the private sector who are taking a transfer of business from the public sector.

Rosalind Connor, pensions partner at global law firm Jones Day